S&P Global Ratings' Private Markets Analytics and Credit Research & Insights expect the U.S. leveraged loan default rate to remain near 1.5% through June 2025.  This would reflect a very modest decline from the 1.55% default rate in June 2024.

Leveraged loan issuers have been benefiting from tailwinds including the buildup to interest rate cuts, strong financing conditions, and a flurry of refinancings that have reduced near-term maturities. While these factors already contributed to a 0.5-percentage-point decline in the default rate from February to June, further declines could be hard to come by.

There was at least one default from an issuer in the Morningstar/LSTA Leveraged Loan Index in each of the 19 consecutive months from January 2023 through July 2024. In the first half of 2024, the index averaged 1.67 defaults per month. To reach our baseline forecast of a 1.5% default rate, 16 issuers would need to default through June 2025, which would represent a decrease in the tally of defaults.

While the leveraged loan default rate has fallen, risks remain for some of the weakest-rated issuers. The leveraged loan distress ratio (the percentage of performing loans from the index priced below 80), which steadily fell between November 2023 and March 2024, has since rebounded nearly a full percentage point, to 5.83% in July. This suggests investors may be taking a more cautious view of some entities within the index.

Other Scenarios

In our pessimistic scenario, we forecast the leveraged loan default rate could rise to 3.25%.  In this scenario, economic growth would decrease more than expected, possibly turning negative. Meanwhile, rate cuts would take time to flow through and reduce firms' costs of funding, and bankruptcies would account for a growing share of defaults as some companies would struggle to meet cash flow demands amid an economic downturn.

In our optimistic scenario, we forecast the default rate could fall to 1%.  In this scenario, economic growth would be slow yet steady, alongside faster-than-expected interest rate cuts. Demand would remain resilient, supporting borrowers' cash flow until their costs of funding ease.

Falling Interest Rates Could Take Time To Lower Borrowing Costs

Borrowers might have breathed a collective sigh of relief after the Federal Reserve announced a 50-basis-point rate cut at September's Federal Open Market Committee meeting.

However, while lower benchmark interest rates will ease funding costs for borrowers and provide some relief for those struggling to balance cash flows, the benefit could come with a lag. Interest rates on floating-rate leveraged loans may reset monthly, quarterly, or semiannually. For many borrowers, there could be a delay before the cost of funding declines.

Furthermore, risks to growth persist. Geopolitical tensions and the U.S. presidential election, for example, could bring volatility and tightening to financial markets.

Strong Liquidity Has Benefited Refinancing

Refinancing activity was robust through the first half of the year, following significant growth of both loan and bond issuance that has continued well into the third quarter.

U.S. institutional leveraged loan issuance was $329 billion through Aug. 31, 2024, more than double the total from the corresponding period last year and already exceeding the full-year totals of 2022 and 2023. In the same period, U.S. speculative-grade bond issuance was up 58%. And meanwhile borrowers have also found supportive financing conditions in private credit.

As a result, issuers have benefited from ample opportunities to refinance near-term debt or extend maturities. Speculative-grade maturities due from the second half of 2024 through year-end 2025 decreased by 35% in the first half of this year. While speculative-grade maturities through 2027 also fell, the recent refinancing is adding to the debt due in 2028, which is when U.S. speculative-grade maturities now peak.

Near-term refinancing pressure has therefore eased for most, but those that have been unable to refinance debt or extend maturities in the recent favorable conditions could soon face difficulties.

Lower Leveraged Loan Defaults Could Precede A Falling Speculative-Grade Default Rate

With macroeconomic conditions and financing conditions improving, the leveraged loan default rate was 1.55% at the end of June 2024, with 18 issuer defaults in the index over the prior 12 months, down from 22 during the same period one year prior. This is also a swift fall from as recently as February, when the leveraged loan default rate was over 2%.

The dip in loan defaults may be ahead of a broader decline in the U.S. speculative-grade default rate, which we expect will fall to 3.75% in June 2025 (from 4.57% in June 2024). Several recent trends, including high refinancing activity, resilient second-quarter earnings, and solid consumer spending, support the decrease.

The forecast decline in the U.S. speculative-grade default rate, coupled with a steady leveraged loan default rate, would bring these two rates closer to their historical alignment, whereas recently the leveraged loan default rate has been down to around one-third of the overall speculative-grade default rate.

Distressed exchanges, which are excluded from the leveraged loan default rate, are the leading cause of speculative-grade defaults more broadly. Distressed exchanges are at their highest since 2009 and accounted for almost 60% of the speculative-grade defaults over the 12 months through June.

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Differences In Default Rate Measurements

The high proportion of selective defaults in the U.S. has kept the broader speculative-grade corporate default rate higher than the Leveraged Loan Index default rate. This is because the definition of default for the Leveraged Loan Index is much narrower (see table 1). There are important differences in the definitions of default for each default rate series and forecast we analyze in our reports:

• The S&P Global Ratings definition of default determines the U.S. trailing-12-month speculative-grade corporate default rate.
• Within the Morningstar/LSTA US Leveraged Loan Index, we measure the trailing-12-month default rate by number of issuers. This default rate excludes selective defaults from distressed debt exchanges.

Table 1

Table 2

How We Determine Our Default Rate Forecasts

The Morningstar/LSTA US Leveraged Loan Index default rate forecasts are based on recent observations and expectations for the path of the U.S. economy and financial markets. We consider, among various factors, our proprietary analytical tool for the Morningstar LSTA US Leveraged Loan Index issuer base. The main components of the analytical tool are the U.S. trailing-12-month speculative-grade corporate default rate, the ratio of selective defaults to total defaults, a leveraged loan debt-to-EBITDA ratio, the Morningstar LSTA US Leveraged Loan Index distress ratio, changes in the distribution of rated loans toward higher or lower ratings, and the unemployment rate.

Related Research

• The U.S. Speculative-Grade Corporate Default Rate Will Continue Its Descent, Reaching 3.75% By June 2025, Aug. 19, 2024
• Default, Transition, and Recovery: Distressed Exchanges Reached Their Highest Level Since 2009, Aug. 15, 2024
• A Cooling U.S. Labor Market Sets Up A September Start For Rate Cuts, Aug. 6, 2024
• Global Refinancing Update Q3 2024: Near-Term Risk Eases, July 29, 2024
• U.S. Business Cycle Barometer: Recession Risk Remains Above Historical Norm, June 18, 2024